Month: December 2016

Broad-based employee stock ownership is one way to ensure that the wealth created in startups is widely shared by those who helped create the wealth.

But broad-based stock ownership in private companies is thwarted by our tax code. Our tax code discourages the sharing of stock ownership among a company’s workers by taxing workers on the receipt of illiquid shares as if the shares could be sold to generate cash to pay the taxes.

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It has been almost seven months since issuers across the country began raising money through Regulation Crowdfunding (“Reg CF”), which went into effect on May 16, 2016. In the six months since Reg CF went into effect, 160 initial filings for crowdfunding offerings on Form C were made with the SEC. The following summary of the highlights and trends are based on data collected from those Form C filings through November 16, 2016.

The General Landscape

First, the good news – despite the naysayers (including this author), a surprising, but still relatively small, number of issuers took advantage of Reg CF to launch 160 crowdfunded offerings, including six issuers who have launched two campaigns each. Of those campaigns, a total of approximately $13.5 million has been pledged or funded, with nearly $8 million raised in 32 successfully funded campaigns. Unfortunately, all of this is also the bad news – the success rate for Reg CF offerings so far is only 20%; that’s not great. And the total amount raised in Reg CF offerings in this six-month period compares very unfavorably to the amount raised in Regulation D offerings during the same period, which is close to $30 billion. Further, of the nearly $8 million raised to date, over half represents just five issuers, with three of those hitting the maximum Reg CF offering amount of $3 million. That said, this is just a start, and the data from the first six months reveal some interesting trends that could give us a glimpse into how Reg CF will be used in the future.

Industry Focus

One of the big surprises about the types of companies utilizing Reg CF has been the high participation by, and success of, companies in the food and beverage industry, especially small breweries, distilleries and restaurants. Food and beverage companies comprised a total of 17.5% of all campaigns in the first six months of Reg CF, 28.13% of funded campaigns, by far the largest successful general industry category (with the closest trailing category being “Apps”, representing 9% of all funded campaigns). It’s possible that the affinity groups associated with food and beverage producers create a built-in audience for crowdfunding. Compare food and beverage’s success with the experience of “tech” companies, including apps, online platforms and other technology-related businesses, which have fared particularly poorly with Reg CF – “tech” companies represent 25% of all launched campaigns, but only 12.5% of successfully funded campaigns. The most successful campaign so far, based on both amount raised ($1 million) and number of investors (a whopping 1,396 individuals) was fledgling movie studio Legion M.

Issuers

For a fundraising mechanism designed to assist small private companies to raise small amounts of capital, it is not surprising to discover that most of the companies utilizing Reg CF are relatively young. The median age of a Reg CF issuer is about two years, and with almost 62% of all issuers formed since January 2015, and about 28% formed just since Reg CF went into effect! That said, there are some older companies utilizing this new method – about 20% are older than four years, and one issuer has been in business since 2003. The companies’ geographic diversity is impressive – campaigns have been launched in 32 states and the District of Columbia. California represents the state with the most campaigns (30%), with Florida (10.6%), Texas (8.1%) and New York (7.5%) trailing a bit further behind. Interestingly, even though only 8.1% of all campaigns were launched in Texas, that state performed disproportionately well, with almost 22% of successful campaigns.

Investors

Participation levels in the campaigns so far have been varied. While the average number of investors across the 122 campaigns that have disclosed their participation numbers is 79 (excluding two large outliers, including Legion M) and the median number of investors is 20 (same caveat), of that number, 20% have had zero investors, and 32% have had 10 or fewer. That said, the number of investors in a campaign does not correlate to its success – one successfully funded issuer raised its funds from just a single investor. Average investment amounts per investor across all campaigns and all successfully funded campaigns is about $950 and $1,200, respectively.

Platforms

To date, FINRA had approved 21 funding portals to host crowdfunding offerings, with 20 having hosted campaigns during Reg CF’s first six month. Of those that have hosted campaigns, WeFunder is far and above the most prolific and successful so far, measured both by number of campaigns (nearly 38% of all campaigns are hosted on WeFunder’s platform) and number of successfully funded campaigns (nearly 60%). This could possibly be first mover advantage, as WeFunder was one of the first portals up and running from Day 1 of Reg CF. It could also possibly be a result of competitive pricing – WeFunder generally charges a 3% commission on successful campaigns, whereas the vast majority of other platforms charge between 5% and up to 12%. About 16% of platforms, in addition to a commission based on a successful fundraising, also take some form of equity compensation. Other prominent platforms include StartEngine Capital (13.75% of all campaigns, but only 6.25% of funded campaigns), NextSeed US (4.4% of all campaigns, but a staggering 22% of funded campaigns and a 100% success rate), and uFunding Portal (11.25% of all campaigns, but 0% of funded campaigns), the last of which now has the dubious distinction of being the first Reg CF funding platform to be removed and banned from the FINRA list of approved platforms for failing to screen for potential fraud by companies using its services.

Offering Details

So, what are investors actually investing in? The three principal categories are equity (common and preferred), which account for over 50% of all campaigns, debt (straight debt, convertible debt and revenue sharing), which accounts for just under 25%, and SAFEs (simple agreement for future equity – a convertible note-like instrument gaining acceptance in recent years), which were offered in 25% of offerings. What is interesting, though, is that SAFEs were sold in over 40% of successful campaigns, whereas equity was offered in only 25% (comprised of 6.25% preferred stock, and 18.75% common). Further, it is somewhat unusual for SAFEs to be the preferred “security” of choice, both because many of the companies offering them may never actually reach a “qualified financing” in which the principal amount of the SAFE converts into equity, and also because many of the SAFEs have a built in redemption feature which permits the issuers to repurchase any equity securities into which the instruments are convertible. Neither of these are investor-friendly features. Of the debt securities offered in successful campaigns, only one campaign offered a convertible note – the rest were split evenly between revenue sharing arrangements and straight debt.

Looking Forward

So, what do the six-month numbers tell us about Reg CF so far, and what we can expect in the future? There certainly seems to be an audience for food and beverage offerings, which is promising for small breweries, restaurants and distilleries hoping to make a go of it. And companies with low capital needs may be well served by a Reg CF campaign so long as the expenses are not disproportionate to the amount raised. On the other hand, for tech-based companies that have traditionally relied on venture capital and angel investors, the data suggest that it is still easier, less expensive (proportionate to amounts raised) and less burdensome from a public disclosure and reporting perspective to continue to raise money through Regulation D private placements. On the platform side, WeFunder appears to have a strong, early lead over competitors, but SeedInvest (an established private placement platform) and IndieGoGo (a brand name in the awards-based crowdfunding space) have both entered the arena and could be formidable challengers to WeFunder’s supremacy. For now, Reg CF offers another, potentially limited, tool in the fundraising toolbox. With a new incoming administration and SEC Chairperson, changes to the Rules might also adjust the regulation in a way that will make it more useful to companies, and more accessible to investors.

Sam’s practice focuses on venture capital, private equity and other securities transactions, counseling start-ups and emerging growth companies, funds and crowdfunding platforms. Sam is heavily involved in the start-up community in New York and regularly advises and mentors young companies and entrepreneurs regarding the legal and business issues that they face, and speaks at many of the local accelerators, incubators and co-working spaces. He is also a key contributor to MintzEdge, an online resource for entrepreneurs that includes useful tools and information for starting and growing a company, and is the co-editor of TechConnect, Mintz’s periodic newsletter on “all things technology” in the legal and business world.

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The Industrial Internet of Things also known as Industry 4.0 has the highest potentials of growth within the IoT, but it hides relevant legal issues.

The figures of the Industrial Internet of Things

According to McKinsey, the IoT will have a total potential economic impact of $3.9 trillion to $11.1 trillion a year by 2025.

But within such figures, it is interesting to see that the highest expectations are around the usage of IoT technologies within factories, as showed in the chart on this side.

Such growth derives, among others, from the possibility to drive efficiency by means of the monitoring of industrial processes, of manufacturing machines and of delivery chains through sensors that can, among others,

predict malfunctionings or failures and therefore avoid downtimes;

identify any lack of service within the manufacturing process, enabling corrections to improve productivity and cut costs; and

track the whole manufacturing process, including workers by means for instance of wearable technologies and geolocation systems, to avoid errors and the misusage of devices or machines and enable their exploitation in a more efficient manner.

The “hidden” legal issues of Industry 4.0 technologies

I had referred in the past to Big Data as the “money maker” of the Internet of Things. And this “formula” is even more valid when it comes to Industry 4.0 technologies.

Are “industrial” data personal data?

Data collected from factories can have a different nature. If such data can be associated, directly or indirectly, to an individual, this obviously triggers privacy issues. This is not a restricted scenario because the efficiencies of the IoT require also to track individuals.

The recent changes introduced by the Italian Jobs Act enable the usage of technologies allowing the monitoring of employees in order to either improve the productivity of a company or perform the working activity. European laws such as the upcoming EU General Data Protection Regulation (GDPR) would prevail over national laws. Therefore the new flexibility provided by the Jobs Act might not result to be 100% reliable and require for instance to run a data protection impact assessment under the terms of the GDPR.

Additionally, once personal data is collected, the goal is to use it with the lowest possible level of restrictions. Therefore the implementation of pseudonymization, segretation or encryption technologies is valuable to further exploit it.

How do you protect data and IIoT technologies?

A tricky issue is to identify the most appropriate right to be used in order to protect data generated from factories. Such data can be confidential information or trade secrets, but is there a copyright or at least a database sui generis right on it?

In a period of time when the protection of software through intellectual property rights such patents is not at its hype, it shall be assessed whether the usage of IoT technologies led to the creation of a protectable model of business.

Finally, when Industrial Internet of Things technologies are adapted to the manufacturing process of the different customers, an issue pertains to the potential design rights on these customizations, especially when there is a relevant contribution from the customer.

Who is the owner of the data?

There is no easy answer to this question. When it comes to personal data, individuals to whom it relates have privacy rights on such data which cannot be waived. Individuals can grant their consent to the usage of its data, but shall keep the control at any time on it, with the right of subsequently withdraw the consent previously granted.

But, as mentioned above, the same data might be confidential information, a trade secret or represent the intellectual property of companies that for instance created large databases containing such data.

Subject to privacy law restrictions, the economic exploitation of data can be contractually agreed. And this is particularly relevant also in the light of the new data portability right that is provided by the EU Privacy Regulation. The right of an individual to have his data ported to the next supplier might not prevent the previous supplier to agree with its customer, at the time of the initial contractualization, a restriction on the usage of the same data for business purposes, even when ported to another supplier. It will be interesting to see the position of data protection authorities on the matter, but this is a fascinating topic.

Is data kept secure?

Cyber risk is exponentially becoming a threat for any business. The EU Data Protection Regulation requires to implement “appropriate” security measures. But this is not just a question of bearing large IT investments since, as recently happened, very smart guys might find an access into a system and all of a sudden the most secure system might become insecure.

And this risk is one of the reasons why interoparability of Internet of Things technologies is having such a hard time. The system of a different supplier interconnected to your system might be the source of a cyber attack. But the Internet of Things requires an “orchestration” of different technologies from different suppliers and you cannot do IoT alone.

Security is a dynamic concept and requires the implementation of organisational and technical measures aimed at limiting the risk of access to information systems and enabling the immediate reaction to a cyber attack. The implementation of a privacy by design approach and the reliance on a cyber risk insurance policy can help, but the whole internal organisation of a company has to change.

What liability if things go wrong?

In case of interconnected technologies such as those of the Industry 4.0, when there is a malfunctioning it is difficult to determine the perimeter of the liability of each supplier. And the matter is even more complicated when it comes to artificial intelligence systems which rely on a massive amount of collected data so that it might be quite hard to determine the reason why a machine took a specific decision at a specific time.

How can liability clauses and service levels be arranged if the efficiency of the technology depends also on information coming from other systems which might not be 100% correct, might be corrupted or just victim of a cyber attach that is due to interconnected technologies? Service levels might not for instance be “static” as they might increase/decrease during the lifetime of a product due to the occurrence of external factors which are not the typical force majeure events.

Such variables make more difficult to build a defence in a potential dispute, especially in case of physical harm caused to individuals since at that stage product liability provisions preventing liability exemptions would apply.

This topic is really fascinating, what is your view on the matter? This is the time when companies shall address such such issues, also because of the upcoming tax savings that are going to be provided for Industry 4.0 technologies.

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Entrepreneurs founding startup companies are often unaware of a potentially significant tax liability that can rear its ugly head with respect to stock issued to founders and employees. Emerging business founders often acquire their stock through a restricted stock purchase arrangement providing for time-based vesting. However, this common structure may set the stage for an unwelcome and unexpected tax bill down the road. An 83(b) election can, in the right circumstances, provide a relatively simple and effective way to avoid the tax.

An emerging business will commonly issue equity to its founders and early employees in the form of restricted stock subject to a vesting schedule that incentivizes those individuals to remain with the company during its critical early years. Unless and until it vests, restricted stock is normally subject to forfeiture to the company if the founder or employee leaves the business. For example, under an ordinary four-year graded vesting schedule, one-quarter of the stock would vest and therefore cease to be subject to the risk of forfeiture after the first year, and the remaining restricted stock would vest pro rata on a monthly, quarterly, or annual basis over the next three years.

The potential tax problem arises because the IRS does not consider restricted stock to be actually received by the founder or employee until it is no longer subject to a substantial risk of forfeiture. The stock’s holder is therefore deemed for tax purposes to acquire the stock in installments over time as it vests, rather than all at once when originally issued. As restricted stock vests according to the agreed vesting schedule, the founder or employee would be subject to taxation based on the value of the stock at the time of vesting, and this taxation will be based on the recipient’s ordinary income tax rate and the value of the stock on the vesting date. If the emerging business is successful and performs well, resulting in the company’s value increasing year-over-year, the holder of the restricted stock may become subject to an increasing tax liability as his or her equity vests. And there is no corresponding tax relief in the event that the value of the business subsequently declines. In addition, the holding period for determining the future capital gain or loss treatment upon the disposition of the stock will not start to run until the shares vest.

For an example of how the tax would apply in the real world, assume that a startup company founder were to acquire 100,000 shares of restricted stock valued at $0.01 per share at the time of issuance, subject to a four-year graded vesting schedule. One year later, the company has substantially increased in value so that the founder’s restricted stock is then worth $5.00 per share.

Under the vesting schedule, one quarter of the founder’s stock would vest, and those 25,000 newly-vested shares would have a total fair market value of $125,000. The founder would have to include that $125,000 of value as ordinary taxable income for the year in which the shares vest. One can easily imagine a similar scenario leading to an unexpected and painful tax burden.

An 83(b) election can provide a solution. 83(b) refers to a section of the Internal Revenue Code that allows a person acquiring restricted stock to choose to be taxed upfront based on the value of that stock at the time of issuance, notwithstanding that the shares are unvested. The holder of the stock making such an election is taxed on the difference between the fair market value of the equity at the time of issuance and the price, if any, the holder paid for the equity. In the case of a founding employees, the purchase price and value of the restricted stock is typically a very low or nominal amount because the startup has little value at the time of original issuance. If the purchase price for the stock equals the stock’s fair market value, then no taxable income would result from the transaction. In addition, since the value of the shares will have been included in the holder’s ordinary income, the holding period for capital gain or loss purposes will begin to run as of the date of issuance.

A person acquiring restricted stock can make an 83(b) election by filing a relatively simple form with the IRS within thirty days after issuance of the equity. However, anyone considering making an 83(b) election with regard to the acquisition of equity should consult his or her tax advisor before doing so. The election is irrevocable once made, and may not make sense for every situation. In most cases, however, the ability to make an 83(b) election can offer an emerging business founder a welcome relief from a possible future tax headache.

Daniel H. Peters is a Partner in the Los Angeles office of Locke Lord LLP where he counsels clients engaging in domestic and cross-border corporate and financial transactions in a variety of industries. Mr. Peters concentrates his practice on mergers and acquisitions, joint ventures, strategic alliances, investments and similar transactions. He regularly represents clients in the purchase and sale of both public and private companies, and has substantial experience advising both strategic investors and issuers in venture capital and similar investment transactions. He also counsels both public and private companies in various legal aspects of their business operations and activities, including corporate governance and compliance matters. He advises emerging companies in various stages of growth, providing legal and strategic guidance in all phases from formation through exit. In addition to corporate transactional matters, Mr. Peters also has experience representing both financial institutions and borrowers in commercial lending, equipment finance and public finance transactions.

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A typical sale transaction can take six to eight months to complete from the time the decision to sell is made. Consequently, it is important that any business owner seeking to sell his or her business in the near term take immediate steps. The following are some key questions every potential seller should ask to assess their readiness and some key steps they should take to make sure they are ready for a sale.

Are your corporate records up to date and accurate?

Buyers will typically require a seller to represent that its capitalization and corporate records are accurate and up to date from formation through the date of a sale. Despite the importance of these records, industry sources report mistakes in company capitalization and stock ledger records of up to a third of private companies.1 Mistakes discovered after a deal expose sellers to liability, and mistakes discovered during a transaction cost companies valuable time and money and could result in a sale not closing.

How many stockholders will need to approve a sale? Is any other party’s approval required?And how likely is it approval can be obtained?

Many private venture-backed companies today have gone through multiple financing rounds. Some of these rounds may have added new investors or imposed conditions that must be met or stockholder approvals that must be obtained in the event of a sale. In addition, if the company has any outstanding debt or other securities, the holders of those instruments may have separate and independent approval rights. Given the added time pressure, companies should start evaluating which groups of stockholders (or other parties) will need to approve a sale and how likely it is that such approval can be obtained. Waiting until the sale process has begun under a strict deadline can put a seller in a tough negotiating position. It may then face having to negotiate key deal terms with not only a potential buyer, but also with its own stockholders in order to obtain their approval. If the seller plans to rely upon a voting agreement, that agreement should be reviewed to confirm what type of transaction triggers a voting obligation and how extensive that obligation is. Analyzing stockholder voting rights and understanding the approval requirements under any debt or other security instruments now can prevent the complexity that would result from a three-way negotiation among the seller, the securities holders, and the prospective buyer and save valuable time.

How accessible and assignable are your company’s “material” contracts, and will the terms of the contracts, particularly employee contracts, be acceptable to a buyer?

Buyers will likely want to review a seller’s “material” contracts. Whether or not a contract is material depends on a company’s individual circumstances, but contracts with officers and other key personnel, important vendors and customers, financing agreements, contract templates, and government contracts (if any) will likely need to be provided to a buyer. If a seller is unable to quickly locate these documents it may give buyers the impression the selling company does not efficiently run its business operations. This not only costs time, but also affects a buyer’s overall impression of a company’s value.

Also, contracts may require approval or a notice to permit the seller to transfer the contract to the buyer or to permit a change in control of the seller caused by the sale. Again, in a time crunch, this can put a seller in the precarious position of having to negotiate with the buyer and its employees, customers, vendors, and/or financing sources. Employment contracts with officers and key personnel require additional scrutiny as the buyers will likely want to retain some or all of these individuals, and the terms of their employment, severance, and any change of control payments may need to be renegotiated during the sale process. A renegotiation of compensatory agreements can take a significant amount of time and cause management to lose focus on the key terms of the sale itself. Sellers seeking to close a sale should have their contracts evaluated by legal counsel to determine materiality and transferability and should have the terms of employment and other compensatory arrangements reviewed as soon as possible to avoid unnecessary delays.

Are your company’s financial records in good order?

Providing a prospective buyer with accurate and complete financial statements is a prerequisite for any sale. While some buyers will accept unaudited financial statements, depending on the size of the transaction, most buyers will require audited financial statements for at least the last completed fiscal year prior to the closing of the sale. An audit, especially a first-time audit, of a company’s financial statements can take months to complete even if there are no surprises. Companies should carefully review their internal controls and procedures, financial policies, and any “off balance sheet” transactions now to avoid any surprises that could delay the delivery of an auditor’s opinion on the company’s financial statements.

How strong are your company’s compliance policies?

Almost all business activities are regulated in some way, but it is often difficult for companies to determine which regulations apply to their business and to further determine if they are in compliance with all applicable regulations. Buyers will, nonetheless, expect a company to comply with all applicable regulations whether a selling company is aware of these regulations or not, and to make representations to that effect in the purchase agreement. In light of this, companies should evaluate the state of their compliance with applicable governmental regulations before entering into a sales transaction.How well protected are your company’s intellectual property assets?

A company’s intellectual property is often its most valuable asset and, for most technology companies, may be a primary reason a buyer is interested in purchasing the company. Issues impacting intellectual property rights discovered during a transaction can delay or kill a deal. Problems found in advance can often be remedied, but these actions may take time. Consequently, companies should review their intellectual property portfolio now to determine if there are any risks with respect to their intellectual property assets.

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1 Paul Koenig & Mark Vogel, Tales from the Trenches, Third Edition, printed by R.R. Donnelly and Shareholder Representative Services, Jan. 2012. (“In SRS’s experience upwards of a third of the [stockholder ledger] spreadsheets received [from companies] have issues that require further clarification before distributions can be made.”)

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Since a private placement memorandum, usually abbreviated as the PPM, is the norm in most deals, the founder should familiarize himself with the standards for memorandum preparation, keeping in mind that, like any legal document, there are various audiences. The audience composed of potential plaintiffs (and, theoretically at least, the SEC enforcement staff) will read the document against the requirements contained in the cases imposing liability. The audience composed of investors will read the document for its substantive content: “What are the terms of the deal?” To professional investors interested enough to become potential buyers, the private placement memorandum is a handy collection of only some of the information they are interested in, plus a lot of surplus verbiage (the empty language about suitability standards, for example). To the issuer, it is a sales document, putting the best face possible on the company and its prospects. To the managers, the memorandum is a summary of the business plan. Indeed, it may incorporate the business plan as an exhibit or be “wrapped around” the plan itself—a memorialization of how the business is to be conducted.

The first page of the PPM, the cover page, contains some of the information one might see on the front of a statutory prospectus: name of the issuer, summary description of the securities to be sold, whether the issue is primary (proceeds to the issuer) and/or secondary (proceeds to selling shareholders), the price per share, the gross and net proceeds (minus selling commissions and expenses), and a risk factor or two (that is, the offering is “highly speculative” and the securities will not be liquid). Some would argue a date is important, because, legally, the document speaks as of a certain date. However, if the memo becomes substantively stale between the offer and the closing, it is critical that the issuer update and circulate it; omission of material information as of the closing is not excusable on the theory that the memo displays an earlier date. Moreover, a dated memorandum will appear just that—dated—if a few months elapse and the issue is still unsold. A related issue is whether to specify a minimum amount of proceeds that must be subscribed if the offering is to go forward. If the financing is subject to a “minimum,” a reference belongs on the cover page. It makes common sense that there be a critical mass in most placements; however, a stated requirement that X dollars be raised or all subscriptions returned inhibits an early-closing strategy—the ability to “close,” if only in escrow—with the most eager of the issuer‘s potential investors. Such “closings ” may not be substantively meaningful; the deal may be that the “closing” will be revisited if more money is not raised. However, a first closing can have a salubrious shock effect on the overall financing; it can bring to a halt ongoing (sometimes interminable) negotiations on the terms of the deal and create a bandwagon effect.

The cover page should be notated, a handwritten number inscribed to help record the destination of each private placement memorandum. It is also customary to reflect self-serving, exculpatory language (of varying effectiveness in protecting the issuer), that is:

1. The offer is only an offer in jurisdictions where it can be legally made and then only to persons meeting suitability standards imposed by state and federal law. (The offer is, in fact, an “offer” whenever and to whomsoever a court designates.)

2. The memorandum is not to be reproduced (about the same effectiveness as stamping Department of Defense papers “Eyes Only,” a legend understood in bureaucratese to mean, “may be important … make several copies”).

3. No person is authorized to give out any information other than that contained in the memo. (Since the frequent practice is for selling agents to expand liberally on the memo’s contents, it would be extraordinary if extraneous statements by an authorized agent of the issuer were not allowed in evidence against the issuer, unless perhaps they are expressly inconsistent with the language of the memo.)

4. The private placement memorandum contains summaries of important documents (a statement of the obvious), and the summaries are “qualified by reference” to the full documentation. (A materially inaccurate summary is unlikely to be excused simply because investors were cautioned to read the entire instrument.)

5. Each investor is urged to consult his own attorney and accountant. (No one knows what this means; if the legally expertised portions of the private placement memorandum are otherwise actionably false, it would take an unusually forgiving judge to decide the plaintiff should have obeyed the command and hired personal counsel.)

6. The offering has not been registered under the ’33 Act and the SEC has not approved it.

The foregoing is not meant as an exercise in fine legal writing and the avoidance of excess verbiage. Certain legends are mandatory as a matter of good lawyering—a summary of the “risk factors”; a statement that investors may ask questions and review answers and obtain additional information (an imperative of Reg. D); and, of course, the language required by various state securitiesadministrators. A recitation tipping investors that they will be required in the subscription documents to make representations about their wealth and experience is generally desirable, particularly in light of cases finding against plaintiffs who falsified their representation. However, in my opinion, a cover page loaded with superfluous exculpations may cheapen a venture financing, signaling to readers that the deal is borderline, in a league with “double write-off” offerings in the real estate and tax-shelter areas.

A well-written private placement memorandum will follow the cover page with a summary of the offering. This section corresponds to a term sheet, except that the language is usually spelled out, not abbreviated. The important points are covered briefly: a description of the terms of the offering, the company’s business, risk factors, additional terms (i.e., anti-dilution protection, registration rights, control features), expenses of the transaction and summary financial information. The purpose of the summary is to make the offering easy to read and understand. As stated, suppliers of capital are inundated with business plans and private placement memoranda; the sales-conscious issuer must get all the salient facts in as conspicuous a position as possible if he hopes to have them noticed.

At this juncture, it is customary to reproduce investor suitability standards, identifying and flagging the principal requirements for a Reg. D offering, that is, the definition of “accredited investor.”

Issuers should approach offerings that have stated maximums and minimums with caution. The SEC has made its position clear. If the issuer elects to increase or decrease the size of the offering above the stated maximum/minimum, each of the investors who have signed subscription agreements must consent to the change in writing. It is not open to the issuer to send out a notice to the effect that “We are raising or lowering the minimum and, if we do not hear from you, we assume you consent.” The issuer must obtain the affirmative consent of each investor, which may be a bit difficult if the investor is, at that point, somewhere in Katmandu.

Investors should be aware that issuers sometimes do not want the investors to know certain information. For example, some issuers elect to code the numbers on the private placement memorandum so that no investor knows he is receiving, say, number 140; he is, instead, receiving “14-G.”

Finally, the current trend is to prepare both a full placement memo as well as a brief summary, such as the so-called “elevator pitch”, a concise summary that can be read while riding in an elevator. Venture capitalists are chronically short on time and a 40-page document is likely to be left unread if this is the only pitch material available.